The UK economy is showing some signs of growth, but nothing like pre-crisis levels. The burden of public debt is still too great, andifficult reforms must be made to the structure of the economy. But who do we call?
The government’s answer is Mark Carney, who starts work as the new Governor of the Bank of England at the end of June. Carney, a Canadian, will take office in Britain as an unelected official in one of the most powerful financial and regulatory positions in the British economy. Once installed, he will find himself at the centre of a highly sensitive and political situation. The debate is raging in Britain—as it is in other countries buffeted by five years of financial crisis and slump—about how to restore the economy to robust growth and what role a central bank can play in this process. These are controversial questions; Carney will be expected to come up with answers.
When George Osborne announced his appointment late last year, he called him “the outstanding banker of his generation.” But Carney’s appointment is no mere technocratic assignment. The first foreign governor, he will come under strong pressure to shake up the Bank’s governance, culture and efficiency. With the government now more than half way through its term of office, can Carney deliver, or is the Chancellor piling an unrealistic weight of expectation onto his shoulders?
Carney is certainly a different kind of central banker from Mervyn King, whom he is replacing. Aged 48 and 65, respectively, they come from opposite ends of the baby boomer generation. King had a long and distinguished academic career prior to joining the Bank in 1990. Appointed Governor in 2003, he was previously the Chief Economist and, later, Deputy Governor.
Carney, in contrast, joined Goldman Sachs aged 23, becoming a senior executive. He then served as the Deputy Governor of the Bank of Canada, the central bank, and as a senior official at the Canadian Department of Finance. He became Governor of the central bank in 2008, and in 2011, Chairman of the G20 Financial Stability Board. At the Bank of England, Carney is expected to oversee the construction of a more robust, trustworthy financial system. He will have strong interests in the financial services (banking reform) bill that is working its way through parliament, but his principal task will be to simplify and improve the ways in which the Bank makes decisions on such matters as interest rates and the regulation of the banking sector.
Many of the Bank’s most important decisions are taken by committee and Carney will probably find that this system could have been better designed. The Bank’s internal committees are set up to function independently from each other, with predominantly internal Bank members. To make his mark, Carney must ensure that they work closely together and bring in external expertise to counter the Bank’s group-think problem.
Fixing the financial system will largely go on away from the public gaze. The higher profile part of the job will be on monetary policy—the question of how much money the Bank allows to circulate in the economy—and how the bank is helping the economy to achieve what he has called “escape velocity.” Like his peers in the United States, Japan and the eurozone, he will experiment with unusual monetary policies to lift the tempo of economic growth. But five years after the crisis erupted, the economic effectiveness of quantitative easing (where the bank buys up government debt in order to inject money into the economy) seems exaggerated. There is, moreover, a rising chorus about the adverse unintended consequences of QE, such as the dangers of inflation and the erosion of savings rates and pension values.
The Chancellor told parliament in March that he is looking for “monetary activism” to boost the economy. But what does this mean? The Bank’s main interest rate has been 0.5 per cent since early 2009, and the rate at which the government borrows from markets has halved since then to around 2 per cent.
The best efforts of the Bank will be of limited help in the present slump—what economists call a “balance sheet” recession, which can’t end until debt and income have been brought back into line. So while the Bank can keep borrowing rates low, encourage households and companies to borrow or refinance more cheaply and spur investors to buy assets, the problem is that this hasn’t got at the underlying problem. The government hopes that recent reforms to the Bank’s remit will bring change.
Osborne has asked the Bank to do three things, that just happen to reflect the Bank of Canada’s modus operandi since 2009. First, the Monetary Policy Committee, which sets interest rates, is to engage in “flexible inflation targeting,” which means that it will worry less about inflation and more about growth. Second, it may use “unconventional monetary policy instruments” to support the economy, meaning that it will find new ways to inject money into the system by purchasing private sector assets. Third, it may wish to issue explicit “forward guidance” on interest rates, to give investors and borrowers advance warning on changes in rates (conditional on economic performance.)
Some of these ideas, such as inflation targeting, have been tried before but informally. QE has just had its fourth birthday and in that time the Bank has bought £375bn of government bonds, quintupling the size of its assets from about 5 per cent of GDP before the financial crisis to more than 25 per cent. This is bigger than QE in the US, where a debate has started about winding it down, but smaller than in the eurozone and, especially, Japan, which is now on course to double its QE from about 30 per cent of GDP to about 60 per cent by the end of 2014.
It is expected that the Monetary Policy Committee, which sets interest rates at the Bank, will call for a further £50-75bn of QE soon after Carney’s arrival—but to what end? QE cannot address the dearth of investment, low productivity, weak trade or the handicapped financial system. Moreover, it is feared that it has unintended consequences, For example by suppressing interest rates, it can deprive households, pensioners and savers of interest and annuity income. It has also increased companies’ defined benefit pension scheme deficits, pressuring them to maintain high levels of cash, according to the National Association of Pension Funds. And by boosting asset prices, QE has been called welfare for the rich. Politics aside, better-off people tend to spend less of any additional income than middle and low income families. The Bank itself estimated last year that 40 per cent per cent of the £600bn increase in the value of stocks and bonds since 2009 had accrued to the richest 5 per cent of households.
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There are only two policy options that would change the tools at the Governor’s disposal. The Chancellor could ask Carney to drop the inflation target and replace it with one for nominal GDP—in other words, tell the governor that it is his job to achieve economic growth. This he would do by adjusting the supply of money until the monetary vale of GDP rose back up to 5 per cent, its pre-crisis level.
Carney has talked about GDP targeting, while Osborne has said the idea is “innovative” and merits debate. It may be worth a try—but if it were simply to inject money into the system, the Bank would be unable to determine what was real growth and what was inflation. A large dose of inflation would not help Britain’s long-term economic prospects.
Another option that has been articulated recently by Adair Turner, the former head of the now-defunct Financial Services Authority, is called “Overt monetary financing.” This would take the Bank and the Government into uncharted and very sensitive territory. This option is designed to finance (or monetise) the government’s deficit, or part of it, directly, without involving banks or a penny of new government borrowing. Money would simply be printed by the bank and given away.
This could be effective at a fraction of the scale of QE. Imagine £100bn were spent in this way—a little more than a quarter of what has been spent on QE. £50bn could recapitalise the banks, enabling them to write off bad assets and lend to creditworthy companies and consumers. A further £30bn could be spent by the bank on infrastructure investment and job creation and £20bn could be used to cut taxes to give the economy a shorter-term boost. What’s not to like?
Simply, it is the political subordination of the Bank to the government as its financing agent. This may be seen as the thin end of a wedge leading to inflation and bigger public debt, either of which could put the Chancellor’s political credibility beyond repair. And yet, these are extraordinary times—it might be worth considering a framework for a limited and targeted programme of direct financing, which safeguards the Bank’s independence over the medium term. In the end, pushing forward in this way to achieve economic escape velocity may do less damage to the Bank’s political credibility than not pushing at all, which has been the fate of the Bank of Japan.
Carney’s conundrum, as he well knows, is that central banks cannot create sustainable long-term economic growth, but only the conditions for economic and public policy to gain traction. Those conditions can be exploited only if public policy itself ceases to be a drag on the economy—so whether Carney can refresh the economy depends iown economic and budgetary strategy. It also depends on new monetary tools, which are also up to the Chancellor to sanction.
The new Governor will certainly be judged on his attempts to strengthen the UK’s financial system as part of the structural fix for growth. He is also in pole position to help influence the government about how monetary policy might interact better with the budgetary strategy to create durable growth. It will be disappointing, however, if Carney is expected to wave a magic wand, without a change in official policy or a significant upgrade to the existing tools of monetary policy.
Carney will find himself at the centre of an intensely political debate about how to foster growth. Perhaps he will prove extraordinarily lucky in taking up the post just as recovery begins. He might then reap the benefits of his predecessor’s work—and the credit for it. But if recovery stalls, he will be reminded of the weight of expectations on him—some of which is unjustified. It is important to remember that when it comes to growth, there’s only so much the Governor of the Bank of England can do.
